GDP falls back by 0.1% as interest rate rises bite

Monthly GDP fell by 0.1% in May following growth of 0.2% in April, the latest ONS statistics show.

Looking at the broader picture, GDP has shown no growth in the three months to May, with industry experts saying that "large price rises and increase in interest rates are starting to bite on the economy".

Production output fell by 0.6% in May after a fall of 0.2% in April, and was the main contributor to the fall in monthly GDP in May.

The construction sector fell by 0.2% in May following a fall of 0.9% in April, while services output flatlined and output in consumer-facing services fell by 0.2% following growth of 1.1% the previous month.

Richard Carter, head of fixed interest research at Quilter Cheviot, commented: “As the government and Bank of England scramble to bring inflation down, there are signs that the large price rises and increase in interest rates are starting to bite on the economy as growth fell over the month and flatlined over the last quarter. The UK economy has done well to avoid a recession to date, but how long this can continue when rates are expected to reach 6% and beyond remains to be seen. Indeed, you just have to look at the data from the Bank of England’s recent stress test on the UK banking system to see that there are skeletons lurking in the closet when it comes to mortgage risk and people rolling onto much higher rates.

“Furthermore, while the labour market remains very tight, it is beginning to show signs of weakening and may start to roll over soon, exposing the economy to both a weaker consumer and corporates beginning to struggle. The savings accumulated during the pandemic cannot be relied on for much longer and the effects of inflation and interest rate rises to date will ultimately have sucked a huge amount of money out of the economy.”

“That said, unless economic growth turns persistently negative or we see a dramatic sudden drop, the BoE will press on with the rate rises. But, rate rises have a lag between action and reaction so we are really only seeing the first hikes really taking effect. This puts the BoE in an incredibly difficult position as it could very easily overtighten and make the economic situation worse. As a result, it will want to see inflation coming down and quickly so it can ease the pressure on the economy and begin the long journey back to more normal, palatable rates.”

Sam North, analyst at trading and investment platform eToro, said: “UK GDP has fallen back slightly in May, down 0.1%. The UK economy limps along, continuing to fail to return to pre-pandemic levels. While the focus is still on inflation and interest rate hikes, ultimately what matters to the Government and households is whether the economy is growing and improving their situations as a result. That it has eked out little-to-no improvement this year is testament to the problem the economy now finds itself in.

“Flatlining GDP presents an issue to the Bank of England which is still looking to quell inflation through further rate hikes. Price rises have remained stubbornly high despite the lacklustre growth of the economy, and wages and the employment market have also been resilient which leaves the bank with little else but to keep hiking.

“Ultimately the governor has warned that a recession may be necessary to bring price rises back to target. This won’t be good news for most households that are already struggling with cost-of-living rises but the harsh truth is the labour market has to give if inflation is to be tamed.”

Nicholas Hyett, investment manager at Wealth Club, added: “May’s GDP numbers paint a confused picture of the state of the economy.

"While the economy shrank modestly in May, that could be down to the extra bank holiday for the Coronation as well as industrial action across the health, rail and education sectors. If true that would suggest the underlying picture is of an economy that remains strong, despite the Bank of England’s attempts to cool activity with higher interest rates.

"Longer term though, there are signs the economy could be running out of gas. The housing market seems to be slowing, with less construction activity in housebuilding, and recruitment is seeing weakness too – potential canaries in the coal mine that suggest the economy has reached a turning point and is sliding from growth to contraction.

"We suspect the Bank will take no chances and continue to hike rates, but the job of balancing inflation and economic growth isn’t getting any easier.”